Frustration in Indian Law

On this blog, we had previously
looked at the judgment
of the Supreme Court of India in Energy
Watchdog v. CERC and connected appeals. An
earlier post had examined the decision, and had concluded that the Court “arguably misstated the law when it found
that the mere existence of a force
majeure clause would prevent the parties from bringing an
alternative claim under section 56….” The decision of the Supreme Court
presents an interesting opportunity to examine the nature of several legal
concepts. In this post, I concentrate on the doctrine of frustration. It seems
to this author that the best explanation for the judgment of the Supreme Court
is that (as a matter of Indian law) the doctrine of frustration is not at all a free-standing doctrine at
all, but is only a question of construction of contracts.

The facts which fell for
consideration before the Supreme Court were summed up earlier.
The basic issue was whether “force majeure” and “change in law” provisions in
PPAs between Adani Power (and other generating companies) and the Gujarat Urja
Vikas Nigam were triggered on account of a 2010 Indonesian regulation
stipulating benchmark coal prices. Put simply, the contractual question on
frustration would be whether the 2010 Indonesian regulations were an event
frustrating the PPAs. The underlying contracts for supply of coal were
presumably entered into for a long term, with the result that the prices for
supply of the coal were agreed at a lower rate. This lower rate would have been
in the contemplation of parties at the time of fixing the pricing for the PPAs.
Indeed, the coal supply agreements were to be annexed to the PPAs. Did the 2010
Indonesian regulations amount to a frustration of the PPAs?

The Supreme Court noted its
earlier precedent around section 56 of the Contract Act – these include Satyabrata Ghose v. Mugneeram
Bangur (‘If an untoward event or
change of circumstance totally upsets the very foundation upon which the
parties entered their agreement, it can be said that the promisor finds it
impossible to do the act which he had promised to do…’), and Alopi Parshad v. Union of India
(‘[it is only if it is demonstrated that
the parties] never agreed to be bound in a fundamentally different situation which
had unexpectedly emerged, that the contract ceases to bind… the performance of
a contract is never discharged merely because it may become onerous to one of the
parties…’)

The Court also referred to
English law, including the Suez canal cases (Tsakiroglou v. Noblee [1962] AC 93), where it was held that the
closure of the Suez Canal did not amount to frustration (even though the goods
would now have to be shipped around the Cape of Good Hope). Tsakiroglou was a case where a different method of performance (i.e. going
around the Cape of Good Hope, rather than through the Suez canal) was not, on
facts, sufficiently fundamental. Indeed, Treitel (13th edition) notes,
“the seller in the Tsakiroglou case would
have made [a profit] if his plea of frustration had been upheld, for the market
price of the goods had risen more than the extra cost of carriage via the Cape
of Good Hope, and this fact may have had some influence on the decision that
the contract remained in force…” There was thus sufficient reason in Tsakiroglou to demonstrate that the method
of performance was not intrinsically fundamental, and hence the contract was
not frustrated due to events requiring a different method of performance.

Citing the above cases, and
English law, the Court concluded that the PPAs could not be considered as being
frustrated. It held:

… the fundamental basis of the PPAs remains
unaltered. Nowhere do the PPAs state that coal is to be procured only from
Indonesia at a particular price. In fact, it is clear on a reading of the
PPA as a whole that the price payable for the supply of coal is entirely
for the person who sets up the power plant to bear. The fact that the fuel
supply agreement has to be appended to the PPA is only to indicate that the raw
material for the working of the plant is there and is in order. It is clear
that an unexpected rise in the price of coal will not absolve the generating
companies from performing their part of the contract for the very good
reason that when they submitted their bids, this was a risk they knowingly took…
the fact that a non-escalable tariff has been paid for, for example, in the
Adani case, is a factor which may be taken into account only to show that the
risk of supplying electricity at the tariff indicated was upon the generating company.

This is an important passage,
because it shows that the enquiry on frustration is – like many other
contractual questions –a question of whether the relevant risk was contemplated
and allocated. The Court has not really given detailed reasons in this passage for
why it concluded that the risk of increased coal prices were on the generating
companies. The only reason in the passage above is that the tariff was a non-escalable
one. But that is hardly conclusive, especially in a situation where the pricing
was based – to the knowledge of both parties – on an underlying supply
contract.

Another earlier
post noted, “The Court has skirted
the issue of protecting the sanctity of the contract by relying on unrelated
precedents and not construing the contract itself…” With respect, that is
perhaps not taking into account the full reasoning of the Court. The Court’s strongest
reason appears later in the judgment, when the Court notes that the question of
frustration must be decided in the backdrop of the express contractual
provisions in place. There was a detailed force majeure clause in the PPA which
in terms excluded “changes in cost… of fuel”. Ultimately, the question of
whether a contract is frustrated or not is purely as a question of constructing
the contract (rather than as one of applying an external legal rule).

This is also borne out by the further
holding of the Court also that “general
recourse to section 56 is not available when a contract contains a force majeure
clause which on construction by the Court is held attracted to the facts of the
case, Section 56 can have no application…” This is, with respect, no misstatement
of the law if one accepts the theory that the doctrine of frustration is
essentially simply a rule of construction of the contract. If frustration is
essentially a question of construction, then a general reliance on the
principle will be unavailable when there is indeed an express provision to be
construed – it would be quite inconceivable for an implied term to override an
express term.

The Court’s reasoning thus seems
to situate the doctrine of frustration clearly within the domain of contractual
construction. It shows that the enquiry is entirely one of construction of the
relevant contract – with express provisions, the task may be simpler; but even otherwise,
the Indian doctrine of frustration is best understood as giving effect to
parties’ intentions on what counts as a “fundamental” change, without imposing
any external legal rule on what does and does not count as a frustrating event.

This reading of the law is
however at some tension with Satyabrata:
for there, the Court expressly said that the doctrine of frustration is not one
based on constructing a contract or finding an implied term, but is really a “rule
of positive law”. The Court there rejected the construction theory only on the
basis that “there is no question of finding
out an implied term agreed to by the parties
embodying a provision for discharge, because the parties did not think about
the matter at all…” With respect, this (a) was not a finding essential to
the ultimate decision in Satyabrata;
and (b) misunderstands the principle of objective construction and the true
nature of implication of terms.

In other words, Energy Watchdog is an important
recognition of the proposition that the “doctrine” of frustration can best be
understood – notwithstanding Satyabrata
– as a question of construction of contracts. What tilted the balance in Energy Watchdog was the Court’s approach
to the question as one of ascertaining parties’ intents in allocating risks,
and of the interpretation of the PPA at issue. The decision must not be
therefore read as one laying down a rule of law that economic impracticability can
never be a frustrating event.

[Note 1: This post does not
independently offer any justification for why the ‘construction’ theory is the
best explanation of the doctrine. I only note that if the theory is rejected, then
there does not seem to be any basis on which the Courts can ascertain what
exactly is a “fundamental” change. For instance, in the absence of a detailed
force majeure clause, it is as likely that the change in the cost of fuel would
indeed be ‘fundamental’ to long term agreements in the energy sector. The
construction theory enables Courts to apply settled principles of
interpretation and implication in the task and thereby introduces objectivity
into the process.]

[Note 2: The relevant clause in the exclusions
on force majeure said: “Force Majeure
shall not include … (ii) the following
conditions, except to the extent that they are consequences of an event of
Force Majeure… changes in cost of
the plant, machinery, equipment, materials, spare parts, fuel or consumables…”
In other words, changes in fuel price was not itself a force majeure event (and
therefore not a frustrating event). But the clause comes with an important rider:
changes in cost of fuel will indeed be a force majeure event if that change in
the cost is itself a consequence of another force majeure event. We will look
at questions of interpretation of these clauses in a subsequent post. For now,
it is important to note that the decision of the Court must not be seen as absolutely
ruling out pleas of frustration on account of economic hardship or
impracticability.]

The opinions expressed herein are those of the contributors (which shall, for these purposes, include guests) in their personal capacity and do not, in any way or manner, reflect the views of the organizations that the contributors are presently associated with, or that have previously employed or retained the contributors. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.

Many of the links on this blog will take you to sites operated by third parties. The contributors of this blog have not reviewed all of the information on these sites or the accuracy or reliability of any information, data, opinions, advice, or statements on these sites. The contributors do not endorse these sites, or opinions they may offer. These third-party links are offered solely for the purpose of discussion and thinking on Indian corporate law and other related topics. It is also possible that some of the pages linked may become inactive after the lapse of a period of time.